Q3 2018 Earnings Call
At this time I would like to welcome everyone to the DXP Enterprises 2018 third quarter conference call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question and answer session. If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad. If you would like to withdraw your question press. The pound key. Thank you Kent E Senior Vice President and Chief Financial Officer, You May begin your conference.
Thank you Sharon this is Kent Yee and welcome to Dxp's Q3, 2018 conference call discussed to discuss our results for the third quarter ending September 32018, joining me today is our chairman and CEO David Little.
Before we get started I want to remind you that today's call is being webcast and recorded and includes forward looking statements.
<unk> results may differ materially from those contemplated by these forward looking statements a detailed discussion of the many factors that we believe may have a material effect on our business on an ongoing basis are contained in our SEC filings. However, DXP assumes no obligation to update that information as a result of new information or future events.
During this call we may present, both GAAP and non-GAAP financial measures a reconciliation of GAAP to non-GAAP measures is included in our earnings press release, the press release and an accompanying investor presentation are now available on our website at IR Dot DXP Dot com.
I will now turn the call over to David to provide his thoughts and a summary of the third quarter financial results.
Thanks, Kent and thanks to everyone on our 2018 third quarter conference call today.
Welcome and thank you for joining us this morning, and thank you to all the Dx people for your hard work.
Next people either come to a DXP facility or interact with a customer each and every day, providing 100% effort to do a day's work in a day one.
<unk> team sales operations corporate driving stakeholder success and value creation, our year to date results through nine months ending September 32018 are a direct reflection of the DXP team work together aspiring to be the best solution for.
All our customers' needs.
DXP had another solid quarter demand remains strong in the third quarter and we continued to experience sequential increases in our quarterly sales per day basis.
We have now gone eight straight quarters with sequential increases in our average daily sales for the quarter.
We continue to believe that our value proposition to our customer is superior to our competition. Additionally, we continue to remain on track for gross margin improvement that we outlined at the beginning of the year.
A result year over year have been consistent with our expectations and in line with our financial goals to grow 20% year over year through a combination of organic sales and acquisition growth.
Yes.
In terms of those areas, where we have been looking for more consistent improvement in gross margin such as DXP is engineered to order business and our Canadian safety services business. Both have shown consistent improvement in gross margins since Q3 of 2017 and from a year over.
Year basis have shown meaningful improvement.
As it pertains to the operating environment, the Ias M and PMI manufacturing index continued to be above average over the last 12 months. This supports the organic sales inquiries, we have experienced through Q3. Additionally, the metalworking business index continues to show strength.
In terms of tariffs and price increases we believe our comments in Q3 were correct and that our current exposure is well understood and being effectively managed there have been related price increases as a result of tariffs, but again DXP is.
Positioned to effectively manage and or find other sources to cover any tariffs or related causes.
Plus our pump works brand has made in America.
In terms of oil and gas quarterly average oil prices drilling and ducks continue to increase.
Quarterly average oil prices for Q3 are up 45% from Q3 of 2017 and 2% from the second quarter of 2018.
Overall momentum continues in our business and we remain focused on a DXP smart recovery and transitioning to the accelerated efficient growth as we move into 2019, our goals for growing the topline and bottom line as well as being fast convenient and customer driven.
For all our customers remains our focus in terms of our publicly stated goal of 10% plus EBITDA margins year to date, we have improved 128 basis points compared to this time last year and we are on path that we expect as we continue to grow sales improve.
Gross margins, we will create the operating leverage and thus the EBITDA margins we expect.
Turning to our results total DXP revenue of $308 million for the third quarter of 2018 was 22, 3% increase year over year.
This reflects stability rebound in growth in our end markets as well as the addition of application specialties.
For the third quarter applications specialties contributed $12 1 million in sales adjusting for the acquisition of <unk> applications specialties total DXP sales increased 17, 5% year over year.
Again this is our.
Consistent with our financial goals of growing the business through both organic and acquisition driven growth.
As we move into 2019, we expect to continue to see strength in our organic sales and we will look to add more growth via acquisitions in terms of sales increase by segment. We continue to see strength in our capital project MRO and OEM business <unk>.
Innovative pumping solutions sales increased 50% year over year to $76 7 million, while service center sales increased 16, 7% year over year to $187 8 million in supply chain services sales increased eight 9% year over.
Year to $43 6 million <unk>.
Innovative pumping solutions increase was primarily driven by increase.
As in Dxp's pump works product and modular packaged equipment for the onshore market.
Sequentially Ips experienced a three 2% increase from Q2 of 2018, the Q3 of 2018 or $2 4 million sales uptake in terms of the strength in the Ips backlog. It has continued to grow through 2018 Ips.
Quarterly average backlog increased 49, 2% from Q3 of 2017 to Q3 of 18, and 22 2000, Skus a 26, 1% sequentially from Q2 to Q3 of 2018.
The service center year over year sales growth was primarily driven by increases in our rotating equipment safety products and services and metalworking product divisions.
Within service centers, we saw particular year over year strength in DXP safety service southwest southeast regions as well as our steel division.
Dxp's overall gross profit margins for the third quarter.
We're 27, 3% a 71 basis point improvement versus Q3 of 17 adjusting for the acquisition of ASI gross margins were 27, 6% or 106 basis point improvement.
Over Q3 of 2017.
<unk> gross profit margins expanded significantly from Q1 to Q2 and remained in line in Q3 based on our expectations and commentary going into 2018.
The improvement in gross profit.
Margins through the third quarter are a result of combination of sales increases and Ips segment, along with improvement in the average gross profit margin on capital related projects and the consistent strength and improvement in service centers MRO business.
SG&A as a percent of sales declined.
217 basis points going from 24% in Q3 of 2017 to 21, 8% in Q3 of <unk> 18 at the end of the third quarter DXP had approximately 2660 full time employees in terms of my thoughts on the SG&A.
SG&A will increase as expected and reflect our investment in our people and our organization as we focus on accelerating growth going into 2019.
We're a sales driven organization and we expect to make investments in our sales team as well as the operations and corporate teams that support such growth.
SG&A includes both fixed and variable costs and as we all know in terms of dxp's fixed costs as we grow our sales our fixed costs as a percentage of sales will decline and this will help us achieve our 10% EBITDA goal.
Dxp's overall operating income margin was five 5% or $16 8 million, which includes corporate expense and amortization.
This reflects a 288 basis point improvement in margins over Q3 of 2017 that being said, we still have a ways to go to full recovery and feel there is opportunity in our operations to be more efficient. This quarter. We continued to benefit from the leverage we get is SG&A growth is less.
Less than the overall sales growth within the business plus gross profit margin improvement.
Ips is operating income margin was 11, 4% service centers operating income margin was 11% and supply chain services operating margin was eight 9%.
Supply chain services experienced margin contraction, which is a result of higher than normal ramp up costs associated with seven new sites.
We're expanding the seven new customer sites, whereby we hire the personnel convert the customer store rooms to our standards, which causes DXP to incur upfront cost once we go live revenue start.
Sales among along with an improvement in margin should come along with the completion of the startup phase.
Overall, DXP produced EBITDA of $23 2 million versus $13 5 million in 2017, a year over year increase of $9 7 million or 71, 9% EBITDA as a percent of sales was seven 5% versus five.
4% in Q3 of 2017.
In summary, we are pleased with our overall momentum we are on pace. This year to deliver 20% sales growth year over year, while improving EBITDA margins, while we have made progress over the past two years coming off the bottom. We believe we still have room to dry.
Better growth and operational execution.
We know that DXP has a differentiated compelling value proposition DXP sales operation and corporate functions remain energized and continue to work towards creating value for our customers.
XP is on path of its financial goals, driving organic and acquisition sales growth EBITDA margin improvement and earnings per share increases during the quarter. This included 22% sales growth, 72% EBITDA improvement and 188.
Percentage increase in earnings per share respectively.
XP is has a great team focused on producing great results for our customers our suppliers and our shareholders alike. All three business segments performed well during the third quarter, we will continue to deliver margin expansion, while ensuring operational efficiency.
Efficiencies and investing in people tools and automation where appropriate.
We will drive change innovate for growth and lead smarter.
That I will now turn it back to him to review the financials in more detail.
Thank you David and thank you to everyone for joining us for a review of our third quarter financial results as David said Q3 was a great quarter for DXP and our results are in line with our expectations and reflect the momentum. We are we were anticipating going into fiscal 2019.
As David mentioned, we are growing through a combination of organic and acquisition driven sales the Q.
<unk> 2018 financial results Mark our eighth consecutive quarter of increases with respect to quarterly sales per business day.
Total sales for the third quarter increased 22, 3% year over year to $308 million adjusting.
Adjusting for the $12 1 million in Q3 sales contribution from ASI organic sales increased 17, 5% total sales growth for the third quarter was supported by all three business segments, reflecting the continued expansion we are seeing from existing and new customers and the overall relative strength of our end markets average.
Daily sales for the third quarter were $4 9 million per day in Q3, 2018 versus 4 million per day in Q3 2017, adjusted average daily sales for ASI average daily sales for Q3 increased 17, 5% or $4 7 million per day.
The overall growth reflects what we're seeing in some of our key end market indicators through the first nine months of 2018, including the rig count U S oil and gas production drilling the metalworking business index, the PMI and the overall average increase in the price of oil.
The Ism's PMI manufacturing index has moved from a reading of 62% for June to 59, 8% reading for September the trend continues to be above the average over the last 12 months of 59, 2%. This supports that organic sales increases we have experienced through Q3, and particularly in our industrial end markets.
Additionally, the metalworking business index continues to show strength with a reading of 56, 9% in Q3 average rig count increased by one rig in Canada, and 105 rigs in the U S compared to the Q3 average in 2017.
In terms of our business segments, all three experienced sales growth year over year with Ips showing the greatest improvement increasing 50% followed by our service centers, which experienced 16, 7% growth year over year and supply chain services was eight 9% growth similar to Q2 businesses within our Ips segment, which experienced year over year sales.
Both in Q3 include our configured to order engineered to order re manufacturing businesses and our branded private label pump offering. Additionally, we have seen growth or rebound in projects focused on onshore applications.
Regions within our service Center segment, which experienced meaningful sales growth include the southwest and southeast regions. Additionally, we saw meaningful increase within our seal and metalworking product divisions. These businesses are located in Texas, the northeast and north central regions of the U S with a growing presence in the Pacific northwest with our.
Asaf acquisition in terms of supply chain services as David mentioned, we are in the process of implementing seven new sites that should start to impact revenue in Q4, and moving into Q1 and Q2 in 2019.
Turning to our gross margins Dxp's total gross margins were 27, 3% adjusting for the acquisition of ASI.
Margins were excuse me 27, 6% in Q3 versus 27, 8% in Q2 Dxp's total gross margins for Q3 reflect the progress we continue to make in our engineered to order business and our Canadian safety services.
A five basis point decline from Q2 to Q3 reflects a 73 basis point contraction in Ips gross margins from Q2 to Q3, which was primarily the result of project mix. This was offset by a 31 basis point improvement in service Center gross margins in terms of operating income combined business segment operating income margins improved 231.
Basis points year over year versus Q3, 2017 total DXP operating income increased 158, 3% versus Q3 2017 to $16 8 million.
Ips had the greatest uptick improving operating income margins 784 basis points to $8 7 million of operating income followed by service centers, which had 130 basis point improvement to $20 6 million supply chain services decreased 140, 104, excuse me basis points year over year. This was primarily driven by the degree decrease in gross profit.
<unk> associated with the implementation of seven new SaaS website Fts sites excuse me in revenue not fully scaling as mentioned earlier turning to EBITDA third quarter 2018, EBITDA was $23 2 million up 71, 9% from Q3 2017.
Year over year, EBITDA margins increased 217 basis points, primarily reflecting the fixed costs SG&A leverage we experienced as we grow sales sales growth of 22% with 11% SG&A growth year over year. This translated into three two times operating leverage in Q3.
As we move through the cycle, we should experience continued operating leverage as long as we continue to drive organic growth and consistent improvement in gross margins.
In terms of EPS. Our Q3 net income was $8 4 million. This is up $5 4 million a 130, 183% versus Q3 2017. This resulted in earnings per diluted share for the third quarter of <unk> 46.
Turning to the balance sheet in terms of working capital our working capital increased $4 9 million from the prior year and $2 6 million from Q2 to $211 6 million in Q3, we remain focused on providing the capital to support growth in our businesses working capital as a percentage of the last 12 months sales for the third quarter was <unk>.
<unk> 18, 1%. This is above our historical average, but reflects a 67 basis point improvement compared to Q2, <unk> and is consistent with our averages during this fiscal year.
The main driver of the increase in working capital includes cost and estimated profits is in excess of billings and inventory.
Costs and estimated profits increased $11 $5 million from Q4, 2017, and inventories up $25 1 million from Q4 2017.
This reflects DXP carrying higher levels to support our revenue growth and investment in project related work.
<unk> inventory turns at seven six times down from eight five times a year ago.
From Q2 inventory is up $5 8 million in costs and estimated profits is only up 489000 in terms of cash we had $16 4 million of cash on the balance sheet as of September 30th.
Terms of Capex Capex in the third quarter was $2 2 million or 0.0.
0.7% of third quarter sales compared to the same period in 2017, Capex dollars are up $1 2 million Capex.
Capex during the third quarter reflects investments made within our Ips business segment, including the purchase of patterns for our manufacturing business and some smaller items, including various tools and equipment. We also are making investments in software to enhance our sales and corporate.
Operations.
Turning to free cash flow, we generated solid operating cash flow. During Q3. This quarter, we saw cash flow from operations of $16 8 million and $9 8 million year to date through Q3. This puts US ahead of where we were this time last year by $1 3 million for Q3 and the nine months ended September 30, we generated $14 6 million.
$2 1 million of free cash flow respectively.
We add the $2 5 million in proceeds we received from <unk>.
Settling our corporate building during Q2, DXP has generated $4 $6 million of free cash flow through Q3 versus $6 4 million a year ago, while growing the business 17, 5% organically.
We are always looking to enhance and improve our cash flow generation. We are comfortable where we are at the end of Q3 with further improvements to come in the future.
Return on invested capital or ROIC increased to 126 basis points from Q2 to 19, 5% and continues to improve as we drive margins and operating leverage in.
In terms of our capital structure as we discussed in Q2, we repriced our term loan b, reducing our borrowing cost of LIBOR, plus 475, reflecting a 75 basis point reduction this generated interest expense savings in Q3, and we will continue to look for opportunities to optimize our cost we have two main covenants under the ABL and term loan b, including the <unk>.
Stretched coverage in the secured leverage ratio at September 30, our fixed charge.
Coverage ratio was three three to one and our secured leverage ratio was 271 total debt outstanding as of September 30 was $249 6 million.
In conclusion as we finished 2018 strong and start planning for 2019, we are pleased with our ability to have eight sequential quarters of increases with respect to quarterly sales per business day. This has included organic sales and acquisition growth EBITDA margin expansion with room for improvement and meaningful diluted EPS growth momentum.
Has been good and we look forward to pushing this into 2019.
At this point ill now turn the call over to questions for David.
At this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad.
Just a moment to compile the Q&A roster.
And your first question comes from Joe Mondello with Sidoti <unk> Company. Your line is open.
Hi, guys good morning.
Good morning, Joe.
So I wanted to ask just about sort of you mentioned about pricing and costs.
Is that a net positive or a net negative in terms of trying to stay ahead of inflating costs.
So.
I think it's a positive and a positive first of all it's a positive for our pump works.
Manufacturing and brand because it's made in America and so therefore, we don't have any incremental increase in cost.
And so that helps us.
Being more competitive in the marketplace from other pump manufacturers that are making stuff in China.
And et cetera.
The other.
Suppliers and people.
The price increases we're seeing really are in the 3% to 4% range Theyre not were not seeing 25%. So people either have a blended cost or whatever and so they are raising prices and so we haven't seen that in a long long time and as.
As you know distribution loves price increases because our inventory increases in value and as long as the price increases are reasonable and justified then we are able to pass those on to our customer.
Okay, and I'm glad you mentioned pump works because I wanted to ask about that how has the.
Feedback and adoption rates with your customers how is that fine.
Over the last how has that trended over the last few years since you introduced that.
You mentioned, how more competitive you are as some of the OEM manufacturers I assume are manufacturing their pumps overseas.
Could you talk a little bit more about that as well.
Okay.
So.
Pump works.
As you know is there is not a real company and so it is not.
Household name and yet when.
When we added that to our <unk>.
DXP channel a pump experts.
We have we felt like we have done extremely well.
Were they.
Exceeding.
What we've done in the past with other brands and so.
Now.
That said you know 15 and 16 were.
We're tough years, so we kind of I think we did really really good during that time, but.
It's really.
Taking off in 17, and 18 to the point now where we're having to buy additional you saw some capex expenses and stuff, we're having to buy extra machines to keep up with demand.
So that.
Manufacturing has a fixed cost component to it so.
Sales volume goes up soda profitability and so we're seeing that and so we're we're very pleased with pump works.
And has the growth rate there been above or below the company average sort of revenue growth.
Our pump works as part of Ips and Ips is at 50% growth rate.
Okay.
And that leads me to the backlog that you see your Ips you've stated that it was up.
Quite significantly.
I assume we can.
Looking at the order trends that Youre seeing I assume things are really still really healthy and.
The environment looks pretty good could you just sort of comment a little bit more on that.
Sure.
We've.
We're coming to.
At the end of the year, the oil and gas piece.
People typically have.
Capital budgets.
And so there's.
There are some people that are kind of exhausted their capital budgets, but.
What happens this time of year.
Is that people are working.
In terms of the.
Designing and using our expertise and put in.
Projects, together and getting them quoted getting them.
Getting getting numbers so that they can.
Budget for next year, along with some people get a lot of equipment that ships at the end of the year a lot of times, our fourth quarter is our one of our strongest quarters.
It has always been that case, but but but it can be and.
So what we're seeing this year is that we're seeing a lot of quoting activity a lot of a lot of effort and a lot of people planning for 2019, which we feel very good about.
Okay and the gross margins at Ips were down from the second quarter, I think Kent mentioned sort of a mix.
Issue.
What are the gross margins look like in the backlog.
Do you anticipate margin expansion or contraction at all.
How does the mix look like in the backlog.
I think that.
We're.
We're driving increased margins.
The.
That said.
The mix is important.
If we're doing.
If all of our business is coming from 6% to $8 million projects, where the margins are smaller.
They shouldnt necessarily be but they but they are.
And if we're doing a million dollar projects the margins or are greater.
So we're having.
A mix of those that I don't know what that really looks like going forward.
I hear about all million dollars orders and a $6 million orders, but so I'm not quite sure what the what the mixes there but <unk>.
Even on the $6 million or trying to get our margins up.
Million dollar order that we get good margins, we're trying to still get them up so I think we should see Ips have.
Incrementally better gross margins.
That said with all Okay. Go ahead, sorry go ahead, that's fine Joe the only thing.
Alright.
Joe the only thing I was going to add is I think to what David said is.
Honestly, we've been harping on gross margins not just with you guys, but internally in our organization and so I think we've got our teams focused on it and.
Yes.
These jobs.
<unk> have different life cycles. If you will some are six months or nine months or so.
Dependent upon that mix, which in any given quarter.
We don't have necessarily a lot of control over.
Impact on gross margins.
Slightly up or down and so I think we're focused on it but we have additional measures just to make sure I know Todd Hamlin, our senior VP of sales for service centers and Ips. For example, he is getting his eyes on some orders that maybe in the past historically, we may have not looked at and refine <unk>.
Alan So he is just making sure that when guys are quoting our better network.
Those margins are where we expect Joe I want to I want to I think this was worth commenting on because.
Maybe <unk> been around wall here. So I appreciate good governance or the length of time you have done so.
When we were.
Back in the two.
2014, or 13 air.
We have we had a lot of offshore packaging.
And we had a lot of engineered to order type packages that also went offshore.
And both of those that market.
Whether it was in South Africa or in the Gulf of Mexico, We made higher gross profit margins back in those days.
Those were more complex jobs, there were more engineering to them.
And there was fewer people.
They could do that type of work and we made higher gross profit margins now that we have shifted to onshore.
Yeah.
Along with kind of the midstream pipeline business to our product mix has changed we have done a fantastic job of growing that business back it's going to it's going to produce really good results and but its probably never going to have those two.
13 gross profit margins again.
And less.
Is that right and B, if there's any other kind of dynamics at play we need to think about when we're looking at the seasonality here.
Yeah, No I mean I think.
A couple of comments one yes, we have been.
Combined organic plus acquisitions kind of call it roughly around the 20% you know this.
This quarter, 22%.
So we fully expect that ASI has been a strong performing acquisition for us. They are ahead of budget at this point through Q3 and.
And so we expect that going into Q4 that said.
You do have an additional business day going into Q4, you have 64 business days, but you have the holidays and so.
We're mindful of kind of the more recent trends in our business, meaning last year, which you picked up on and the fact that one we've got an election coming up that will stall the world for a moment in time.
Then you have Thanksgiving holiday and then Youll have the Christmas holidays Thanksgiving Falls, obviously on a Thursday. So you get mix mixed mixed performance. The day after Thanksgiving and then this year Christmas falls on a Tuesday so.
Once again, we're just we're trying to factor all of that and obviously, we don't have that crystal ball.
But that kind of feeds our thinking.
But sales per business day for a quarter.
We probably would expect.
Uh huh.
Continued improvement is the way I'll put it we don't normally give guidance, but continued improvement I think Blake you are trying to refer to a generalized comment.
We feel good about doing over 20%, we werent trying to.
Target that exact numbers so.
If you are reading in a ditch.
Position that's appropriate so.
So Ryan Ryan it lets understand that from a financial modeling point of view.
We've we've invested.
Coming off the bottom we've invested quite a bit in working capital and then some capex to grow pump works et cetera.
And so that's kind of where our moneys been been going of late but when.
If organic goes from.
22, and a half to 10.
Well, then we won't be spending that kind of working capital money.
So then we take that money and go out and buy other companies and we've done that very successfully.
Works from a cash flow point of view so.
So we feel comfortable that we're going to be at 20% one way or the other.
Okay and then the other.
Quarter solid gross margin performance and I know you've talked about.
Potential mix headwinds.
And you're not sure about that but historically gross margins are down from our <unk> and <unk> and given the strong performance you had this quarter how should we think about gross margins in <unk>.
Well I think our gross margins just to kind of maybe correct you just directionally a little bit Ryan or are in line with where we kind of discussed at the beginning of the year I think at the beginning of the year.
After Q3 of last year, having that.
Downturn on gross margins.
In the 26% range, we said hey from there we were going to improve call. It 15 to 20 basis points a quarter and so if you net look where we're at we're roughly on top of that.
Through Q3, and so I think once again that commentary remains the same as we go into Q4.
Is it a perfect straight line now with Q2 up significantly yes.
But net kind of where we're at kind of year to date I think were in line with what we expected if that answers your question and Ron I'll, just I don't want I want to add something.
I don't think people.
Eight.
Yes.
The oil and gas market.
Just.
We're concluding the second inning of hopefully a 7% or nine inning ballgame here.
You know over the last couple of quarters, just wondering sort of how you're thinking about cash flow and use of cash.
It doesn't seem like maybe you're too focused on paying down debt. So is M&A the.
Number one focus or.
Well once again I think I think the world needs to be educated a little bit on our capital structure. You know we have a institutional that piece of the term loan b, which has 1% amortization on a full year mandatory amortization on a full year basis, so two 5% per quarter. So.
If we have excess cash it's not like we're going as we have historically, because we just had a basically a revolver and a term loan a and pay down the debt. We have institutional debt piece that only requires us to amortize 1% per year and then we have and we're going into the first year of it then we have what we call an excess cash.
Cash flow sweep at the year end, which has a specific definition I won't go into that now.
That gives us the option basically the pace pay down some debt if the formula spits that out.
So long winded way to answer your question, yes from a capital deployment perspective.
We put that in there to focus on growing the business as we were coming out of the cycle also to optimize our capital structure and allow us just to not be drawn down in conversations with our banks.
Unnecessarily so.
<unk>.
It's built for our growth strategy.